New way to pay off student loans

Sunday

Jan 13, 2013 at 12:01 AM

In the last week of December, the federal government offered recent borrowers struggling with their federal student loans a new, improved and simplified option to manage repayment. It's called Pay As You Earn.

Anya Kamenetz

In the last week of December, the federal government offered recent borrowers struggling with their federal student loans a new, improved and simplified option to manage repayment. It's called Pay As You Earn.

It came not a moment too soon: In the third quarter of 2012, the percentage of student loan borrowers who are behind on repayment leapt from 9 percent to 11 percent. By some measures, in fact, if you count only loans that are currently in repayment, as many as one in five borrowers may be behind. This repayment plan may be welcome news for some of the youngest new grads, half of whom are unemployed or underemployed in jobs that don't require a college degree.

Pay As You Earn was created to help recent college graduates who are having trouble finding jobs and repaying their loans due to the recession. It's for recent and current borrowers only - older borrowers are out of luck. You must have taken out your first loan after the fall of 2007 and have taken at least one loan after the fall of 2011.

It's also only for borrowers of federal student loans - no private or alternative student loans are eligible.

Monthly loan repayment amounts are based on income. Participants must show a "partial financial hardship," which basically means that their payments are high relative to their income, adjusted by family size and the state where they live. A single 2012 graduate with an average debt load, $26,600, and a starting salary of $25,000 would pay over $300 a month under standard repayment, or 14 percent of her income. If eligible for Pay As You Earn, the same person would pay just $69 a month, or 3 percent of her income. After 20 years, the remaining balance on the debt is forgiven.

You can apply online at the website Studentloans.gov for Pay As You Earn as well as for other special federal loan repayment plans such as Income-Based Repayment and Public Service Loan Forgiveness. The calculator will tell you whether you are eligible and what the best choice is for you.

Participating in the program has potential drawbacks. Financially, signing up for an ultra-low repayment plan like Pay As You Earn is a little like making the minimum payment on your credit cards. It's much better to be in an official repayment plan than not paying the debt down at all, but if you can afford to pay more, you should.

In fact, Pay As You Earn payments are set so low that they never make a dent in the principal of the debt. The interest will keep growing on the debt, and after 20 years you will pay much more in total to the government than you would have if you had kept to the standard 10-year repayment plan.

Another important point to consider is the eventual IRS status of your debt. Right now, the taxman considers debt forgiveness as though it were a large windfall in income. For example, let's take the recent graduate paying $69 a month on debt of $26,600. Assuming for simplicity's sake that her income never went up, she would make a total of $16,560 in payments over 20 years. In year 20, her loan balance is forgiven: around $28,000, including the unpaid interest that grew over the years. In that year, 2032, assuming nothing changed, she would owe taxes on the full $28,000, as though she had just earned that money.

For more information, visit the following websites:

The Institute for College Access and Success, which helped develop the policy proposal that formed the basis of these programs: ticas.org